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By Kate Marino

After mostly missing the mark in identifying the warning signals of the last financial crisis, mainstream media types are dead set on not letting history repeat itself. Pundits parsing through data on corporate debt issuance frequently tell the story of junk loan issuance running rampant and lacking the investor protections that could prevent steep losses in another downturn.

While highlighting the data is helpful for headlines, one issue remains: market participants chasing yield don’t seem to care much, despite signs that the quality of today’s covenant-lite loan has deteriorated significantly from the last cycle.

Just four short years after the syndicated corporate loan market emerged from the slumber of the global financial meltdown, cov-lite term loans have skyrocketed to account for nearly two-thirds of issuance, according to Xtract Research, a covenant analysis firm owned by the Mergermarket Group.

Many veteran loan managers once fixated on preserving covenant culture have surrendered to the new environment as the need to put money to work outweighs hunger for tighter loan structures.

"We just have to stick to our basics and do our credit work,” one portfolio manager commented. “The market is what it is and we have to go with what’s out there.

Still, it’s a matter of debate as to whether the superior performance of cov-lite loans during the 2007-08 default cycle is repeatable. Cov-lite apologists rely on data from that cycle showing that first lien cov-lite loans defaulted at a lower rate than the overall market, and, when they defaulted provided better recoveries, according to a special report published by DDJ Capital Management, citing data from Moody’s Investors Service and S&P Leveraged Commentary & Data.

But a host of factors imply that the market should not necessarily expect a repetition in the next cycle of any superior performance stats the 2008 cycle spawned, and that isolating a “cov-lite effect” is virtually impossible, several investors noted in interviews with Debtwire.

For one, the drastic central bank intervention in the financial system beginning in 2008 quickly stabilized then helped improve the economy. That action, which helped cut off distress before it pushed more levered companies into restructuring, is unlikely to be repeated in future cycles.

The differences between then and now also include the quality of the cov-lite component of the market – which has broadened substantially. During the last cycle, cov-lite was largely the province of borrowers with better credit ratings that investors could justify didn’t even really “need” the looser structures, sources agreed.

Now cov-lite loans are accessible for most levered issuers. In 2006 and 2007, only 24.5 percent and 32.7% percent of cov-lite issuers were rated single-B or below, compared with 57% last year, said the DDJ report. Cov-lite loans also represented a much smaller percentage of the whole during the last cycle – 7.4 percent of new issuance in 2006 and 25 percent in 2007, the report said.

What few argue with is the fact that cov-lite contributes to the erosion of total returns since holders lose the ability to reprice a loan when its risk profile deteriorates. Those loans in turn trade poorly and create paper losses for mark-to-market portfolios.

Despite potential pitfalls, avoiding cov-lite deals altogether doesn’t make sense now, especially with no near-term default catalyst, sources said. The low default expectation is in part because so few covenants are out there to trip up borrowers, and also because hardly any corporate issuers have maturities over the next few years – courtesy of the flood of refinancings over the last several years.

For some, the takeaway is that “if you’re basing your decisions on covenants, rather than credit analysis, you’re going to lose,” one portfolio manager said.

This post is brought to you by Debtwire, a Mergermarket company and the leading provider of real-time intelligence, analysis and data on distressed debt, leveraged finance and asset-backed markets. The team at Debtwire is comprised of financial journalists and credit analysts with considerable experience covering trading, law and investment banking. Our reach is global, with separate products covering North America, Europe, CEEMEA, Asia-Pacific, Latin America, ABS and Municipals. For more information regarding Debtwire visit www.debtwire.com.

Kate Marino is Deputy Editor of Debtwire North America. Kate’s expertise spans the leveraged finance market, with a specialty in loans. She can be reached at Kate.Marino@debtwire.com.